In Finance, Size Matters

This study investigates the relationship between production efficiency in financial intermediation and financial system size. The study predicts and tests for the existence of "systemic scale economies" (SSE) effects, whereby value-maximizing intermediaries operating in large systems are expected to have lower costs of production, risk absorption, and reputation signaling than intermediaries operating in small systems. The study explores the mechanics of SSEs and estimates their quantitative relevance using a large cross-country banking data panel. The study shows strong evidence in support of SSEs and finds that the institutional environment, risk environment, and market concentration affect significantly the production efficiency of financial intermediation services. Copyright 2004, International Monetary Fund